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Ritchie Fund Rewrites Rules

Emma Trincal

If anyone needs proof that investing in hedge funds can be a hair-raising experience, Ritchie Capital Management is Exhibit A.

The $3 billion money manager, which is run by ex-football player A.R. Thane Ritchie, has spent the last few months inundating investors with a lengthening list of restrictions that govern everything from when and how much money can be withdrawn from the fund to how its assets are valued. Don't like it? Well, you're free to vote against some of the rules -- as long as you don't mind losing access to your money for three years.

The fund says the steps, which include a 10% limit on asset withdrawals, will be good for investors in the long run, giving managers a free hand to pursue unconventional strategies that promise big returns. Some investors view it less charitably.

"It is a disaster," says one who spoke on condition of anonymity. "They don't give you any information. It's not clear to me what I own."

The fun continued this month, when Ritchie sent a letter to investors explaining that because of the illiquidity of certain investments and an ongoing regulatory probe, Ritchie adopted a new way of calculating its net asset value, which investors use to gauge performance. The missive arrived in mailboxes two weeks after the last quarterly withdrawal deadline of Nov. 15.

"Ritchie made it complicated to distribute assets. It's getting hard to get the NAV," says one investor. As a result, the fund has been hard hit with redemptions, this investor says.

Ritchie agrees that redemptions have occurred. A fund spokesman says more investors did take money out last quarter, but that the situation has since stabilized.

"Due to some changes in fund terms, we had a larger-than-normal amount of redemptions at the end of September. But it was a one-time event, and now we're back to business as usual," the spokesman says.

All this is going on at a fund that isn't exactly lighting up the league. A source familiar with its performance said that Ritchie Multi-Strategy Global, the shop's $400 million flagship, was down 4% in 2005 through the end of last month.

The story shows how mind-boggling the hedge fund experience can be. For a variety of reasons, investors seem inclined to stick with Ritchie, who once played for the Pittsburg Steelers and Chicago Bears. Among other things, his $3 billion shop is benefiting from a voguish trend toward niche strategies that are currently a hit with institutional investors. Recent Ritchie offerings included separate funds devoted to insurance and energy.

The new rules also seem less audacious when viewed next to restrictions being imposed by other funds, particularly ones run by stars. Eric Mindich, a former Goldman Sachs trader, raised $3 billion for his Eton Park fund while insisting that investors agree not to withdraw money for several years.

Still, investors at Ritchie are living with an unusual amount of stress. The vote over whether the company should be allowed to impose a 10% quarterly withdrawal quota amounted to a lesson in game theory that would confuse a mathematics doctorate.

Essentially, investors had three options. They could vote in favor of the gate provision, agreeing to live by its terms if it passed or not if it didn't. They could vote yes with an "opt-out" provision and be subject to no gate provision in any outcome. Or, they could vote no and have all of their money locked up in the fund for three years.

The vote was designed to compel investors to choose the second option, and that is indeed what happened. Investors who liked none of the options could, if they were nimble, vote with their feet and redeem their interests. Still, on top of the complicated ballots, investors had a relatively brief period to make up their minds. The proxy letters were sent July 27, giving investors just two weeks before the Aug. 15 deadline to put in redemption notices for Sept. 30.

December has been no cup of tea for Ritchie investors, either. News about the changes in the way the fund calculates its NAV was contained in a letter penned by Ritchie himself.

From now on, Ritchie wrote, his company plans to segregate a portion of its assets in an account that represents its interest in illiquid assets that can't be redeemed until certain profit goals are realized. The segregated money was stripped out of the NAV calculation, reducing it.

A second provision allows Ritchie to hold back assets in order to build up a reserve fund in anticipation of potential costs associated with a Securities and Exchange Commission investigation. As reported here, Ritchie's fund came up in the complaint charging five former Prudential(PRU Quote) brokers with defrauding mutual fund companies through market-timing.

"The share NAV is calculated net of your pro rata share of a reserve for contingencies related to legal and other costs including potential civil settlements associated with continuing proceedings and inquiries of several government agencies into market practices involving mutual fund share trading," the letter said.

This clause is designed to protect investors who remain in the fund from paying a higher share of the burden in case investors flee the fund, according to a person familiar with Ritchie's operations. But an investor says that the managers, not the investors, should have set that money aside out of their own incentive fees. The clause only applies to those who invested prior to Sept. 30, 2003, as the first formal SEC inquiry was received in writing on Oct. 1, 2003, and mutual fund trading was discontinued immediately thereafter, the letter says.

Ritchie also established a 10% "hold back" provision related to its annual audit. That means that the firm holds 10% of the assets until the audit is completed in April. Such a clause isn't unusual in the industry.

To some observers, Ritchie's strictures, particularly the gates and liquidity provisions, show how hard it has gotten to make money in alternative investments. Investors should be prepared for more rules designed to give managers a virtually free hand to seek return where they can find them.

"I would agree that the pursuit of excess returns in the darker corners of the capital markets is demanding responses like these," says Jim McKee, a San Francisco-based hedge fund consultant with Callan Associates. "The challenge is whether investors want to follow them."

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